New gold bullion backed dollar

Gold and growth: not mutually exclusive

Jan Skoyles, for The Real Asset Co, looks at the claims that a return to the gold standard would restrict growth due to the inelastic supply of gold. This is in contrast to the growth which has been facilitated in the fiat monetary system. She concludes that the issue of enough gold, is not an issue at all.

With reports from the World Gold Council that Central Banks’ purchase of gold have “accelerated notably” many are asking if banks and governments have decided to buy gold in preparation for a return to the gold standard or sound money generally.

Why would we return to gold anyway? Simple, as explained by Sprott Asset Management:
“Gold and silver are not traditional commodities, they are money. Their value lies in their ability to retain wealth in environments marked by negative real interest rates, government intervention, severe economic uncertainty and vulnerable banking institutions”

Many Keynesians and elected politicians dismiss the premise of a modern gold standard citing the uninformed reason of “there isn’t enough gold”.

“There isn’t enough gold” says Helicopter Ben

Mr Bernanke is one of the many notable individuals who have argued that a return to the gold standard, or a sound monetary system, would be impossible because there isn’t enough gold in the world to support growth. He argued this in March 2011, to the Senate Banking Committee, and the assembled accepted these opinions.

I know; it’s scary that Helicopter Ben, whose policy actions have possibly the most dangerous effects in the world at present, doesn’t understand what money actually is. The issue of ‘enough’ gold to back a currency or enough gold for growth is irrelevant.

It is understandable because the majority of us have grown up in a world of money creation and stimulus, where (particularly at the moment) whenever there is a problem our solution is more credit, or if you are the central bank/ government – printing money.

We have grown up in a world where debt is perfectly acceptable because it gets you things, such as an education or a house. For those of us most recently joining the workforce we were in huge sums of debt before even paying our first lot of income tax.

Now across the majority of the Western World we are being told to ignore the history lessons of the Weimar Republic which ruined and humiliated Germany and helped fuel the rise of Hitler, and instead support our governments who suddenly, for an unexplained reason, know exactly how much is just enough to “inject” (print) into the economy.

But when looking at the return to sound money, should we really be asking ‘is there enough gold’? No. This is completely the wrong question.

What is money?

To understand why this is the wrong question we first of all have to understand what ‘money’ is.

The primary role for money, whatever form it comes in be it paper, gold or corn, is as a means of exchange; “money’s main job is simply to fulfil the role of the medium of exchange. Money doesn’t sustain or fund real economic activity,” (Shostak, 2010).

The use of money is an indirect exchange.  It is the direct exchange of goods and services which provides the value. The market will determine the purchasing power of the money, therefore whether there is ‘too much’ or ‘to little’ of the money is not the issue. The commodity which is chosen to back the money supply, gold or silver for example, “will always be sufficient to secure the services that money provides,” (Shostak, 2010).

Money’s second property is as a store of wealth. So far the ‘money’ which we have at present has failed to store any of our wealth. Since 1970 the purchasing power of our money has fallen dramatically. It is for this reason, according to Dominic Frisby, that we pile into asset classes such as houses to preserve our wealth. Tangible assets are often the best protection against inflation, but that’s a discussion for another time.

Therefore, as money is a means of exchange, when governments and central banks embark on a plan of quantitative easing in a fiat monetary system this distorts the value of the currency because the market is unable to determine its value.

The Keynesian argument for quantitative easing, hell let’s call it what it ultimately is – money printing, is that demand needs to be stimulated in order to grow the economy out of a depression. However, as we know from history and today, money expansion does not lead to growth; instead it distorts the value of the money supply. This is at the expense of the greater good and at a benefit to government and the wealthy.

A growing economy does not require an expanding money supply

If the quantity of money was what created growth and wealth then surely poverty could have been eliminated by money printing? If so then Zimbabwe would probably be richer than America or China by now.

As Lewis E. Lehrman, author of ‘The True Gold Standard’ argues:

“Historical and empirical data show that gold convertibility of the dollar, without reserve currencies, creates the least imperfect monetary standard, generating economic growth and price stability over the long run.”

It is strange that gold’s opponents use growth as the argument against a commodity backed currency. The ability of governments to print money has meant they print at a rate faster than that of population growth.

Gold, throughout history, has proved itself to be a far better form of money in regard to purchasing power and inflation. According to the Economist, paper money has an extra hurdle to jump compared to commodity money, the credibility of something with no inherent value. Gold, in comparison does maintain its value and it protects your wealth.

Gold growth

One of the many reasons gold is considered precious is because the new supply of gold is relatively low to that which has already been mined. But that which has already been mined, still exists.

According to Erste Group’s 2011 ‘In Gold We Trust’ the annual growth of the gold supply is approximately 1.5% which is “a much slower rate than all the other money supply aggregates around the globe. The growth rate is vaguely in line with population growth.” Therefore, the inflationary impact of the increasing supply of gold would be almost non-existent unlike the printing practices of today’s central bankers.

Dominic Frisby’s graph from a recent article reinforces Erste Groups’ statement that the gold supply can match that of population growth:

Annual gold production vs. annual world population growth

“The black line shows world population growth, and the yellow line shows annual global gold production since 1500.

You can see the remarkable correlation. Annual gold production and world population growth rise very much in proportion to one another.”

We know now that fiat money does not represent wealth, it is a form of exchange. We also know that if we were to return to a fully backed gold standard, there would be enough ‘money’ to go around. According to Dominic Frisby:

“Gold is very much a natural form of money. Which is why it’s the only currency in history that has never disappeared. Which is just one more point to add to your ever-increasing list of reasons to own gold. “

Wrong Question

So if the question “is there enough gold” is the wrong one to ask, then what is the right one? The right question is how would we back all of the oceans of paper money and credit with gold should we return to honest money? This would require a resetting of gold’s role within the monetary system, and significantly higher gold price as a result. Has the market begun this since 2000? Let’s wait and see…

Jan Skoyles is an economist at The Real Asset Company and contributes to other sites such as Renegade Economist. Jan’s interest in economics lead her to the Austrian school and the ideas of sound money and gold and silver. Read more of her articles.

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About the Author

Jan SkoylesJan Skoyles is Head of Research at The Real Asset Company, a platform for secure and efficient gold investment. Jan first became interested in precious metals and sound money when she met Ned Naylor-Leyland whilst working alongside him in the summer of 2010. Jan then went on to write her undergraduate dissertation on the use of precious metals in the monetary system. After graduating from Aston University in 2011 Jan joined The Real Asset Co research desk. Her work and views are now featured on a range of media including BBC, Reuters, Wall Street Journal, Mail on Sunday, Forbes and The Telegraph. She has appeared on news channels including Russia Today to discuss the gold price and gold investing. You can keep up with Jan's commentary by subscribing to our RSS feed Gold Investment News.View all posts by Jan Skoyles